Gill Capital Partners Client Education Event Review
A Discussion With Jeffrey Kleintop
Thank you to all of our clients and partners who were able to attend our client education event this past Thursday, September 27th. We were thrilled to once again be able to host Jeffrey Kleintop. Jeffrey is the Chief Global Investment Strategist for Charles Schwab and is frequently cited in both national and international media outlets including the Wall Street Journal, the New York Times, Barron’s and the Financial Times. He also appears regularly on news networks like CNBC and Bloomberg TV to share his thoughts on the global investment climate. For those of you who were able to attend, we hope you enjoyed his presentation and ensuing discussion. For those of you who were unable to attend, below is a summary of his main points and key areas of discussion.
Jeffrey’s presentation certainly carried a more subdued tone this year than last, where he called for strong global synchronous growth throughout 2017. He discussed the near-term outlook for the remainder of 2018 as well as what he sees likely transpiring over the next 2-3 years and beyond. He reviewed what he believes are the most reliable recession indicators and shared his views on what they are telling us now. He also made a compelling case as to how a number of investment trends and relationships could be set to reverse in the not too distant future, and how to avoid a “shark bite” if this does in fact occur.
“Why is the market doing what it is doing now?” Jeffrey asserted that it is the continued effects of the recent tax cuts, and not the headlines associated with trade tensions, that have been the most impactful driver of market movements this year. The stock market ran up sharply on a “sugar induced” high following the tax cuts last year and U.S. stocks have been positive in 2018, though muted in comparison to 2017. Kleintop attributes muted returns in 2018 to the markets “reconciling with economic reality,” and while the tax cuts remain a positive force for corporate earnings, the markets are pricing in uncertainty around the mid-term elections and coming to terms with the fact that fiscal stimulus is over. That being said, he believes the vast majority of economic indicators look good, and we are setting up for a strong Q4 and early 2019.
Recession Indicators –What are they saying now? Jeffrey presented his thoughts on two recession indicators, the inflation rate vs. the unemployment rate and the yield curve.
• Inflation vs. Unemployment Rates – Jeffrey presented this lesser known metric as one of his preferred indicators of recession. The indicator simply subtracts the U.S. inflation rate (currently 2.7%) from the U.S. unemployment rate (currently 3.9%), which gives us a data point of 1.2. Historically, when the two rates converge and the difference approaches zero, a recession has generally followed roughly one year later. This makes sense, as following recessions, unemployment tends to be high and inflation low, and we see the opposite in periods of strong growth near the end of the economic cycle. Jeffrey’s take on this indicator is that it’s not yet signaling a recession, there is still a 1%+ gap, but we are getting close.
• Yield Curve – Jeffrey also reviewed the current yield curve, which is a more commonly followed indicator. Every inversion in the yield curve since the 1960’s has happened approximately one year before a recession. There has never been a time that the yield curve has inverted and a recession did not follow. As a refresher, the yield curve compares short-term interest rates to long-term rates. In a healthy economic environment, longer-term rates are higher than short-term rates, and there is a curve when the rates are plotted. However, when the Federal Reserve raises short-term rates, generally during periods when the economy is strengthening, they may push short-term rates higher than longer-term rates. This generally signals an inflection point in the cycle, one in which monetary policy has become too restrictive, and a recession may follow. Jeffrey’s take on this indicator is that while the yield curve is positive by nearly 1% today, it is continuing to flatten and could invert at some point over the next 12 to 18 months. This is not a concern yet, but he is watching closely.
Jeffrey’s conclusion from looking at these two indicators, along with other inputs, is that there are no flashing warning signs of an imminent recession. However, both indicators are nearing the point at which they could signal an upcoming recession. He believes that the next bear market could be coming in the next 12-18 months. He does not believe it will be as dramatic as the last two, however, which were among the worst in history. He believes that the next pull back will be shorter and shallower than the very intense corrections we saw in 2000 and 2008.
Where to invest now & How to avoid “shark bites”
Given Jeffrey’s updated view laid out above, what does he believe investors should be doing now? And how do investors protect their portfolio from the risk of “shark bites” if the environment does change? Turning points in markets tend to happen roughly one year before recessions occur. Jeffrey believes we are approaching that point, and expects to see some of the trends that have been in place for quite a few years to begin to reverse. He highlighted three trends that may reverse in the near term.
• International equities vs. U.S. equities – U.S. equities have been outperforming international equities rather dramatically over the past 10 years. This outperformance has been significant, and relative valuations are extreme.
• Growth stocks vs. value stocks – Growth stocks (high growth companies like Google, Amazon, etc.) have massively outperformed value stocks (stocks with strong fundamentals that are attractively priced, like JPMorgan, Procter & Gamble, etc.) since about 2012. Jeffrey is not sure if growth stocks have peaked yet, but relative performance has favored growth stocks significantly.
• Large-cap stocks vs. small-cap stocks –Small-cap stocks have significantly outperformed large-cap stocks since 2009.
Jeffrey believes that we are likely approaching a reversal point in these trends that have been in place for several years.
• The “sugar high” associated with the tax cuts has largely run its course, but the short-term fundamentals still look good, and Jeffrey believes we will continue to see positive returns over the next few quarters.
• Key indicators are not yet predicting an imminent recession, but they continue to get closer.
• We are likely fast approaching a turning point in major trends, and investors and advisors should make sure portfolios are diversified and rebalanced.
Our investment committee watches these macro trends closely, and we will recommend adjustments if we believe they are warranted. We agree with Jeffrey, and continue to stress diversification and rebalancing.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.